Just like stocks, bonds and real estate, commodities too are a very lucrative class of investment options. Recent years have shown that there is a subtle move by institutional and retail investors towards commodity markets. There has been a great demand for commodities like precious metals, oil, agricultural produce (both food and cash crops), textiles and related raw material, poultry and livestock, and many more. But how to you know which commodity funds to invest in? Let’s study the different types and their pros & cons.
How to select the commodities investment option
# 1: Commodities Futures
A futures agreement allows you to hold a specific volume of a commodity and buy or sell it sometime in the future when the price is right. This is popular with hedge fund and mutual fund managers and speculators who have a higher risk-bearing capacity.
Pros – There are opportunities for a huge gain in commodity futures. Your profits are influenced only by the value of the commodity and not by other secondary factors.
Cons – You need to open a separate brokerage account to trade in futures. The risk factor is very high in the commodities markets, especially for an individual. The commodity could move in either direction, thus escalating either loss or profit.
# 2: Commodities Stocks
Commodities stocks are a little less volatile as compared to futures. Of course, like futures, a thorough research into the market scenario is very essential if you really want to make a killing. Sector-specific commodities may or may not give the desired yield. So most investors prefer to follow the old adage of not putting all the eggs in one basket and diversify into different types of commodities and reduce the risk.
Pros – You do not need an exclusive trading account like for futures. Your usual Demat account will do for stocks trading. Before investing in commodities stocks, you can track the company’s financial status making it less speculative than futures. Stocks are liquid assets and can be very easily converted to cash.
Cons – Company related factors can adversely affect the value of your commodities stocks. Major changes in company ownership, top management, etc. will increase the risk of a downhill slide of share value.
# 3: Exchanged Traded Funds & Mutual Funds
ETFs and MFs have a lower risk factor. Investors, institutional as well as individual, can buy/sell commodities ETFs and MFs to take advantage of the fluctuation in market prices. Their values can be tracked on stock exchanges. The most popular ETFs are precious metals and oil at present and the most popular MF are natural gas and alternative fuels.
Pros – You can trade both MFs and ETFs through your Demat account and don’t need a separate one. ETFs and MFs give individuals access to investment options in energy, oil and natural gas commodities which otherwise have governmental control. Mutual funds are a little safer than ETFs if well managed. Both are liquid assets but MFs carry management fees.
Cons – Some lucrative commodities are not available under the umbrella of ETF and MFs. Also, any negative change in the issuer’s credit status would affect your investment adversely. Mutual funds can be adversely affected by changes in fund managers and company policies too.
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